Will Green Shoots Sprout for Institutional Investors?

In the face of waning transaction volume and leasing activity, many institutional investors are rightfully taking a hard look at their allocations to the commercial real estate sector. Despite the temptation to make radical strategic changes, one leading advisor is recommending that global institutional investors keep the faith when it comes to their commercial real estate holdings.

In a new study, “U.S. View: Real Estate Investing in a Time of Uncertainty,” co-author David Lynn, managing director for New York-based ING Clarion, says history is a good teacher when it comes to how quickly and strongly the U.S. markets could recover from the current recession.

“Over the past 30 years, the U.S. has faced four economic recessions, and each time the interest in institutional real estate investment not only survived but grew stronger,” says Lynn. “We continue to believe that in the long run, commercial real estate remains an attractive asset class in a mixed-asset portfolio for the benefits of diversification, high current cash flow, and as a hedge against inflation.”

Many institutional investors are faced with the denominator effect, or what appears to be an overallotment of funding to real estate that falls outside a predetermined percentage of their overall portfolio. In truth, the value of other investments, namely stocks, has fallen even farther than the value of their real estate holdings.

Lynn says this is a short-term phenomenon, and expects the U.S. economy to resume “moderate” growth in early 2010. “Our current view is for the recession to continue through 2009, with the financial crisis ending in 2010, and a stable economic environment occurring in 2011,” says Lynn.

This view is based on the mean of two scenarios. In his best-case scenario, Lynn expects equity investors to enter the scene later this year, leading to a more stable economy in 2010 followed by growth in 2011. With his worst-case scenario, the financial crisis could run well into 2010 with the global recession not ending until 2011. Ultimately, recovery is dependent on the health of the housing market and the impact of the various governmental programs.

In the meantime, investors should stay focused on the fundamentals while keeping a watchful eye on possible green shoots ahead. “Without question, retaining tenants and maintaining NOI growth are crucial components of active portfolio management in today’s market. Yet we also believe that there will be increasingly attractive investment opportunities in private equity real estate, public REITs, and real estate debt over the next 18-24 months,” says Lynn.

So what looks promising, if and when there is money to invest? To Lynn, apartment, industrial, and grocery- and drug-anchored retail properties will produce better returns than office and hotel investments over the next three years. For example, he expects office rents to decline by at least 15% and hotel revenue per available room to fall more than 10% through 2010.

On a geographic basis, Lynn expects investments in institutional-quality assets in core markets to outperform the broader market in general. His picks for the healthiest markets include several key regions. In Texas, the Dallas-Fort Worth Metroplex, Austin, and Houston are ones to watch. In the Northeast, Washington, D.C. and in the Southeast Raleigh, N.C. should fare well. Out west, Salt Lake City, the San Francisco Bay area including San Jose, and Seattle and Portland to the northwest, are all predicted to outperform other geographic markets based on projected economic growth from 2009-2011.

When it comes to a more liquid real estate investment class, REIT stocks, Lynn predicts that the highly volatile nature of their share prices may continue for some time. REITs had their worst performance year in 2008, following a massive selloff in October and November, but then rebounded in December to post their best share price gain since 1975.

Despite the ups and downs, Lynn says the market has now priced the REIT sector’s downside through 2009. “We believe that the distressed valuations of some public companies are likely to stimulate possible public-to-public and public-to-private takeover activities.

In other words, Darwin had it right, and only the strong will survive.

TAGS: News
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